Auto Sector Investment To Remain Resilient Despite Political Unrest

BMI View : While the recent outbreak of political unrest in Thailand has clearly taken its toll on vehicle sales and production, we do not expect it to derail the auto sector's long-term investment story. Although Indonesia will be a beneficiary of auto sector related investment in the short term, the enduring strengths of the Thai auto sector will make it difficult for automakers in the SEA region to find an alternative production and export base.

The outbreak of political tensions towards the end of 2013 has clearly taken its toll on Thai auto sales and production. Indeed, we recently downgraded our 2014 domestic sales and production forecasts to reflect the deleterious effect of the political turmoil on the sector ( see 'Slashing Forecasts Due To Political Unrest', February 24).

Furthermore, our Country Risk team believes that the current political impasse is unlikely to be resolved anytime soon. Therefore, this begs the question of whether this will derail the long-term fortunes of the country's auto sector.

Holding Up Reasonably Well
Thailand - Value Of Auto Exports, THBmn (LHS); % chg y-o-y (RHS)

Auto Sector Investment To Remain Resilient Despite Political Unrest

BMI View : While the recent outbreak of political unrest in Thailand has clearly taken its toll on vehicle sales and production, we do not expect it to derail the auto sector's long-term investment story. Although Indonesia will be a beneficiary of auto sector related investment in the short term, the enduring strengths of the Thai auto sector will make it difficult for automakers in the SEA region to find an alternative production and export base.

The outbreak of political tensions towards the end of 2013 has clearly taken its toll on Thai auto sales and production. Indeed, we recently downgraded our 2014 domestic sales and production forecasts to reflect the deleterious effect of the political turmoil on the sector ( see 'Slashing Forecasts Due To Political Unrest', February 24).

Furthermore, our Country Risk team believes that the current political impasse is unlikely to be resolved anytime soon. Therefore, this begs the question of whether this will derail the long-term fortunes of the country's auto sector.

On balance, while we remain bearish on domestic demand for vehicles due to the country's political woes, we do not see a protracted political gridlock greatly reducing Thailand's allure as the premier production hub of South East Asia. In this piece, we highlight the impact of the unrest on the industry; suggest a possible beneficiary of Thailand's unrest; and put forward our reasons for retaining a sanguine outlook for the autos sector's long-term investment story.

Thai Exports Remain Resilient

It is worth noting that while the recent political quagmire has decimated domestic auto sales, which tumbled 45.2% year-on-year (y-o-y) in the first two months of 2014, exports have held up reasonably well. We believe this is helped by the fact that trade routes within the country have not been disrupted by the protestors, allowing automakers to continue their export operations. At the same time, carmakers have been quick to divert some of their surplus local production to overseas markets given the sharp fall in domestic demand. This will bolster domestic auto production and chimes with our 2014 forecast, which assumes vehicle production will suffer less of a decline compared with domestic sales.

The accompanying chart illustrates this point well. While the recent unrest erupted sometime in late 2013, auto exports (including components) have held up reasonably well since then. We concede that exports have not seen the same robust y-o-y growth rates experienced in 2012. However, the relatively stable absolute value of exports (see chart below) is testament to the resilience of the sector.

Holding Up Reasonably Well
Thailand - Value Of Auto Exports, THBmn (LHS); % chg y-o-y (RHS)

At present exports make up roughly half of domestic production. However, we expect exports to continue growing over the 2014-2018 period, especially with the onset of the ASEAN Economic Community in 2015, which will see intra South East Asia (SEA) trade rise as tariffs between countries are abolished.

Indonesia Will Benefit From Thailand's Unrest

However, we see Indonesia being a clear beneficiary of Thailand's deteriorating business environment, at least in the short term. We have long held the view that Indonesia remains an alternative production hub in SEA due to its large domestic market, export potential and more stable political climate recently, compared with Thailand.

Our business environment scores support this view. As seen below, both Thailand's short and long-term political scores are below Indonesia, given the former's political woes and the latter's relative political stability. Additionally, our combined auto sector score for Thailand is 49.9 versus 53.7 for Indonesia. While Thailand's auto sector still remains more competitive due to better infrastructure and a more concentrated supplier presence, its worsening business environment has dragged down its overall auto score.

Indonesia Currently Ahead On All Counts
Indonesia And Thailand - BMI Autos Sector And Short & Long-Term Political Risk Scores

We believe firms with a heavy concentration in Thailand could look to diversify some of their production capacity away from the country into Indonesia in order to safeguard against a worst-case scenario of a civil war in Thailand, which would jeopardise Thai export operations.

Indeed, in recent months, some automakers have voiced their desire to hold back on additional investment in Thailand due to the uncertain business environment. Furthermore, the Indonesian government recently announced that it is in talks with some carmakers operating in Thailand, which are jittery about the nation's political situation, to bring over some of their investments into Indonesia. Additionally, the Indonesian government is making a concerted effort to attract more suppliers in the sector (which currently number around 800 firms versus 2,300 for Thailand), which will make it more attractive to original equipment manufacturers (OEMs) as an investment destination.

Indonesia Not A Perfect Alternative

That said, the Indonesian auto sector has issues of its own, not least its infrastructural bottlenecks such as its ageing and overstretched port infrastructure, which limits the country's export potential ( see 'Can Indonesia Become The Detroit Of Asia?', September 24 2013).

Therefore, in our opinion, Thailand will remain one of the premier automotive hubs for automakers in the SEA region given the country's enduring strengths of a strong supplier cluster, skilled labour and the availability of a robust port infrastructure.

Overwhelming Interest In Thailand's Eco-Car Scheme

The strong bidding interest in the recently concluded second phase of the 'eco-car' scheme is further proof of Thailand's draw for manufacturers in spite of its volatile political environment.

The eco-car program is a series of tax incentives afforded to carmakers, which promise to invest the specified minimum amount to manufacture fuel-efficient cars locally ( for more details on the incentives see 'Mazda Lured By Eco-Car Incentives', November 14 2013). The deadline for automakers to submit their proposals for the second phase of the eco-car scheme was March 31 2014, with the Thai Board of Investment (BOI) expecting seven or eight companies to apply for it.

However, the reported number of bidders has exceeded expectations. According to the BOI, 10 carmakers, including five existing eco-car manufacturers, have officially applied for phase two of the eco-car scheme. Furthermore, it is interesting that existing manufacturers are willing to spend more than the newcomers. The five existing automakers are prepared to invest THB86.8bn (USD2.68bn) to produce 753,000 eco-cars and the five new entrants are committing THB52bn (USD1.60bn) to manufacture 828,000 units.

We believe this bidding exercise demonstrates two key points. The first is that OEMs with large operations in the country are unfazed about increasing their investments at a time of political uncertainty. While there is no guarantee that the production licenses will be eventually awarded due to possible changes to the BOI board in the next few months (due to the current political crisis), firms are still keen to boost their presence in the sector. At the same time, carmakers without a significant local manufacturing presence are unable to resist the attractiveness of the sector. The lack of strong alternative production bases is evident as this program only makes sense for companies looking to establish a bigger footprint in Thailand and the Asian region.

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